One of the earliest--and trickiest--decisions for new business
owners is determining what to charge for their products or
services. Some entrepreneurs use elaborate computations. Others
just guess. But if you calculate or guess wrong, you'll soon be
out of business.

"Setting prices is an art, not a science," says Edith
Quick, partner with her husband, Roy, in Quick Tax & Accounting
Service in St. Louis. The art is in striking a balance between the
money you need to stay in business and the customer's
perception of what your product or service is worth.

Here are nine methods commonly used when setting or rethinking
your prices. (Yes, rethinking. You should evaluate and adjust your
prices at least once a year to accommodate changes in competition,
the economy, consumer tastes and your company's needs.)

1. Compare with the competition. Find out what products
and services similar to yours cost in your area, advises Andi
Axman, coauthor with David H. Bangs Jr. of Launching Your
Home-Based Business (Upstart Publishing, $22.95,
800-245-2665).

"Prices vary from big cities like Boston or New York to
rural ones like mine," says Axman, who owns a marketing
communications firm in Epsom, New Hampshire. If nearby competitors
won't reveal prices, try calling similar businesses in other
communities similar to yours, she suggests.

Shahid Kinnare's Timezone store in Memphis, Tennessee, has
numerous watch and jewelry retailer competitors nearby. "So I
look at what services they don't have," Kinnare explains.
"I give free jewelry cleaning for a lifetime. I give a
lifetime guarantee on all my watches."

Posh Impressions, which sells decorative rubber stamps and
scrapbook supplies over the Internet and at retail stores in Irvine
and Brea, California, sets its stamp prices at cost times two, says
co-owner Warren Gruenig.

Many entrepreneurs find such formulas easier than trying to
figure out all their costs or surveying their customers. However,
use any formula with caution. It may not cover all your actual
costs--a quick path to financial disaster. Or you may cheat
yourself out of some profits because customers may be willing to
pay more than the formula dictates.

No formula can substitute for the one number you must know: how
much it costs to make a product or deliver a service. This is your
break-even point and your price floor.

4. Calculate backward. Some service providers and
consultants start with the annual income they want, then calculate
backward, says Roy Quick. If you work 40 hours a week all year and
take a two-week vacation, you'll put in 2,000 hours. However,
service businesses can't bill for every hour. In the first
place, it's virtually impossible to schedule clients for every
single hour of every single day all year. Second, you must do
administrative tasks, marketing, bookkeeping and other duties for
which you can't bill any customer.

The rule of thumb is that you will have 1,000 billable hours a
year. If you want to gross $50,000, you have to bill $50 an hour.
If you want a $50,000 profit, you must carefully calculate your
costs and add that amount into your hourly rate.

5. Add wiggle room. Roy Quick recommends service
providers add a little to their hourly rate "so you don't
nickel and dime your clients to death. If a client calls us with a
question that takes five minutes, we don't charge for that, but
we do track those calls. Then if a client complains about the bill,
we point out all the free services we gave all year."

6. Use "magic numbers." Psychology plays a role
in pricing, says Kinnare of Timezone. "I go for magic numbers.
All my watches are $19.99. When I first started, I charged $20.99,
but they didn't sell as well as [at] $19.99."

Many retail items are priced at a digit less than a round
number, such as $9.99 instead of $10 or $999 instead of $1,000,
because the mind tends to perceive the difference as much greater
than just a penny or a dollar.

7. Use introductory or limited-time pricing. Another
quirk of the mind is that customers perceive your original prices
to be the correct value for your products or services. If you start
low and try to raise prices later, customers will balk. If you
price high at first, you can always reduce prices or add extras
later to attract more customers.

Homebased entrepreneurs sometimes run into customers who think
their prices should be cheaper because they don't pay
commercial rents, Axman says. But homebased businesses still have
overhead that must be included in their prices.

Besides, Edith Quick adds, if you lowball your prices, then
eventually move into a commercial location, you'll have to
raise prices--and that can drive away customers.

8. Charge what the market will bear. The prices you
calculate using formulas or adding up costs plus profit margin are
your ideal prices. "We have to balance our ideal with what the
market will pay," says candy-maker Johnson. "We do about
40 trade shows a year and see what customers are paying. If
we're 40 percent higher [than the competition], then we'd
better have something really special or drop our prices."

Just as your costs put a floor on your prices, consumers will
establish the ceiling. Do market research before investing
thousands of dollars in mass production, distribution and
advertising. If you invent a product, make a prototype; then survey
potential customers about the price they would pay for the
item.

If your survey indicates people won't pay your break-even
price, look at ways to cut your expenses. Or look for ways you can
add value, such as better performance, higher quality, faster
delivery time--whatever will make the product or service worth more
in the customer's mind.

If you can't make your product or deliver your service for
less than customers will pay, you're not ready to go into
business.

9. Charge what you're worth. Many new business owners
suffer from "lack of courage in pricing," says author
Axman. But underpricing can backfire, she adds, because if your
product or service is too cheap, clients may assume it's of
poor quality.

Roy Quick agrees: "You have to bill at the rate you're
worth. We tell [service business] clients `If you're as busy as
you want to be, your prices need to go up.' Many start-ups
aren't charging enough to succeed."

The art of pricing means achieving what you need by delivering
the goods and services your customers want.

Add It Up

To price your product or service accurately, you must calculate
your costs. Here's how:

1. Add up all costs.Fixed costs are constant
no matter how much or how little you sell; they include rent,
property taxes, insurance, advertising, depreciation and interest
on loans. Variable costs fluctuate based on the amount you
sell; they include labor, sales commission, office supplies and
sales tax. Semivariable costs include telephone, electricity
and postage.

(Note: If market research indicates consumers won't pay this
price, you have to cut costs, and/or reduce your markup, and/or
increase the number of units you sell or reduce the time it takes
to complete a project.)